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Kemp: Hedge Funds Return to Oil as OPEC Removes Some Downside Risk

Hedge fund managers stepped up their purchases of oil and refined products last week on growing hopes of a U.S.-China trade truce and that the global economy will avoid a severe slowdown in 2019.

But fund buying has been concentrated in crude rather than fuels, which is consistent with producer club OPEC tightening the supply side of the market while the demand outlook remains more uncertain.

Hedge funds and other money managers boosted their net long position in Brent crude futures and options by 30 million barrels to 203 million barrels in the week to Jan. 22. Portfolio managers have raised their net long position in Brent in six of the last seven weeks, by a combined 66 million barrels since Dec. 4, according to exchange data.

Funds now hold four bullish long positions in Brent for every one bearish short position, up from a ratio of just over 2:1 in early December, but far from the recent peak of 19:1 at the end of September.

Fund managers also increased their net long position in European gasoil for the third week running by 4 million barrels to 15 million barrels. Gasoil positions are up by 13 million barrels since the end of December.

In both cases, however, most of the new buying last week came from the closure of existing short positions rather than opening fresh long ones. It follows the largest sell-off ever recorded in crude and gasoil during the fourth quarter and confirms many fund managers sense prices have found a floor, at least temporarily. The preponderance of short-covering suggests most managers think oil prices will not fall further rather than any great optimism about future increases.

By cutting oil production early and aggressively, OPEC has removed some of the downside risk to oil prices in 2019 but the upside potential remains unclear until the threat of recession is resolved.